When Are Tax Return Required for Legal Entities? The Answer May Surprise You

I was in a meeting with a new client yesterday doing some proactive planning.

This particular investor had just graduated college a little over a year ago and he and his friend decided to get into the flipping business. Although the first year was not a very good one for them, in year two they had seen some good results so far.

This client and his buddy built a very effective marketing system on the acquisition side and an unexpected yet pleasant surprise for them was that in 2014, they made almost as much income from their wholesaling fees as they were making on their flips.

Being brand new to the real estate (and to the business world in general) meant that they had a lot to learn. Being in operations just a little over a year they had already made some big mistakes that cost quite a bit of money.

One of the mistakes they made was that they put the cart before the horse and spent a significant amount of money on forming several legal entities last year before making a penny on their real estate transactions.

It wasn’t until they started getting notices from the IRS when they found out that even though their LLC made no income, it still had filing requirements with the IRS. The truth was, even if their legal entity was losing money in its first year, the IRS still wanted a tax return filed in order for the company to be in compliance.

At first, this investor and his buddy decided to simply ignore the IRS notice. After all, they were really busy running their business and just didn’t have the time to read through the mumbo jumbo in the letter. They figured that if they just looked the other way, the IRS would probably just look the other way and not all this would quietly go away.

The letters from the IRS came more and more frequently but each time it ended up on the trash can. Neither of them really paid any attention to these letters since they knew that the entity made zero income in 2013 and would not owe any income taxes. It wasn’t until they received a notice of levy from their company’s operating bank account that they finally realized that this problem was not going away any time soon.

Once the bank started to levy on the company funds was when both of them started to panic. Also that was the first time they realized that they were in over their head.

When we met with them for the first time, a lot of what was discussed during that initial meeting was brand new information to them. So I wanted to use my blog this week to highlight some of the key points from that meeting in hopes that you will find it to be helpful:

File Your Tax Returns Regardless of Whether You Owe Taxes

What a lot of people do not know is that for most entities, you are still required to file income tax returns with the IRS regardless of whether the entity made a profit for the year.

Even if the entity had zero activities (ie no income and no expenses), there are times when a separate tax return would still be required. Now what about someone who forms an entity that was intended to hold a rental property but the title never transfers? Even in those cases, an entity tax return may be required.

If you are unsure as to whether you have a filing requirement, it is always best to consult with your tax advisor ahead of time in order to make sure that you do not miss any required tax filings.

What a lot of people do not know is that for certain entities such as Partnerships, the late filing penalty could be as high as $195 per month for each partner. Having a quick conversation with your tax advisor can potentially save you thousands of dollars in unnecessary penalties.

First Time Penalty Abatement Program

If you are someone who has failed to file a tax return on time, it is possible to get some of all of the penalties waived.

The IRS has a First Time Penalty Abatement Program where you may be able to apply for a waiver from the penalties if this is the first time that the entity has filed a late tax return.

If Your Business Lost Money, File Your Taxes Anyway!

If the entity resulted in an overall loss during the year, it definitely makes sense to file a tax return since to capture those losses.

For example, if your entity was an LLC, Partnership or S Corporation, the losses may be used to offset taxes on other income you personally earned during the year. On the other hand if your entity was a C Corporation, filing the required tax returns and showing those losses allows you to use those losses to offset future income of the Corporation.

State Filing Requirements

Don’t forget about the state filing requirements.

Each state has its own set of laws in terms of when an entity needs to file a tax return. There are times when a single entity may have tax filing requirements in multiple states depending on what state the owner lives and what state the entity was formed.

If you are an investor who formed an out of state legal entity, be sure to speak with your tax advisor to let them know where the entity was formed. This way you can determine whether one or more tax returns may be needed for your legal entity.

Not all entities require tax returns and not all states require them either. However, if you are unsure whether you have a filing requirement, ask your tax advisor. Of course, if you get an IRS notices…do not throw them away.

Free eBook from BiggerPockets!

Get The Ultimate Beginnner's Guide to Real
Estate Investing for FREE - read by more than 100,000 people -
AND get exclusive real estate investing tips, tricks, and techniques
delievered straight to your inbox twice weekly!

About Author

Amanda Han of Keystone CPA is a tax strategist who specializes in creating cutting-edge tax saving strategies for real estate investors. As real estate investors herself, Amanda has an in-depth understanding of the various aspects of investing including taxation, self-directed investing, entity structuring, and money-raising.

9 Comments

I’m curious, what was the combined tax rate of the wholesaling and flipping business including self employment? I’ve been using rule of thumbs in a blog post and would be interested to see what a real world example looks like. Not sure if your interested in disclosing, but it would be helpful for the flippers out there when they are planning ahead for their tax liability.

Amanda, Excellent article. Many folks do not realize that creating a corporate entity is more than a filing fee. People should get educated on the law and formalities before doing this step to avoid these types of problems.

Wouldn’t this depend on the type of entity. Single Member LLC’s are disregarded entities for tax purposes that don’t file a separate corporate return. As such there should not be any separate filing requirements for a single member LLC correct?

Hi Darin: Thanks for your comment. Yes single member LLCs are exempt from filing income tax returns with the IRS however each state has different state law regarding single member LLCs so you want to check with your tax advisor regarding whether your state requires a separate LLC tax return for single member LLCs.

If the entity never applied for EIN then the risk of IRS sending you a notice is very low. Keep in mind however the state would still have info on this entity and may contact you for a state tax return if required. Of course, if the IRS and state share info then that can lead to the IRS requesting for tax returns =)